Empirical Assessment of Exchange Market Pressure within the West African Monetary Zone.

Mogaji, Peter Kehinde (2017): Empirical Assessment of Exchange Market Pressure within the West African Monetary Zone.

Abstract

The focus of this paper is the identification of currency risks periods (or otherwise) in the WAMZ and to further test the response of exchange market pressure (EMP) to monetary policy related factors in these countries as well as movements in primary commodity prices, given the feature of these countries as primary commodity exporting countries. The first phase of the EMP analysis in this work employed the model-independent statistical method of Eichengreen, Rose and Wyplosz (1996) to derive EMP indices in determining currency crisis susceptibility of the countries under study. The second part assessed the response of EMP to monetary policy across the WAMZ as well as evaluate the similarities in the patterns and strengths of the response of EMP towards checking for compatibility across the WAMZ countries. In this respect, the Girton and Roper (1977) model of exchange market pressure was applied in the model-dependent estimations for the six countries under study. The evaluation of exchange market pressure in the WAMZ employed the use of both annual and monthly data of the WAMZ countries under assessment as well as the CPI inflation data of the US. These data spanning between 2001 and 2015. EMP index were constructed for each of the WAMZ member countries within the contexts of the US dollar and the Nigeria naira foreign exchange markets in the WAMZ. For the model dependent EMP, robust regression method was applied in the estimation. Evidences gathered revealed mixed forms of the absorption of market pressure in the WAMZ, with the majority of the member countries of the WAMZ (including the lead economy) absorbing exchange market pressure through domestic currency depreciation relative to reserves depletion. From the results of the assessments with both annual and quarterly data it cannot be confidently inferred that a common exchange rate and a single foreign exchange market is feasible for the WAMZ countries in the proposed single currency area. The adoption of a single exchange rate in a common foreign exchange market should therefore be considered with caution. The foreign exchange market is likely to be free from future currency crisis. Because of the possible and expected massive influence of Nigeria in the foreign exchange market, foreign inflation may not hugely impact the proposed exchange rate and the external value of the proposed single currency.

• Item Type: MPRA Paper
• Language: English
• Keywords: Exchange Market Pressure (EMP), EMP Index, Currency Crisis, WAMZ
• Subjects: F - International Economics > F3 - International Finance; F - International Economics > F3 - International Finance > F31 - Foreign Exchange; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F45 - Macroeconomic Issues of Monetary Unions

References

Bensaid, B., and Jeanne O. (1997). “The Instability of Fixed Exchange Rate Systems When Raising the Nominal Interest Rate Is Costly.” European Economic Review 41(8):1461–178.

Bussiere, M and Mulder, C. (1999). ‘External Vulnerability in Emerging Market Economies: How High Liquidity Can Offset Weak Fundamentals and the Effects of Contagion.’ IMF Working Paper No, 98/99. July.

Dekle, R. Hsiao, C. and Wang, S. [1999] "Interest Rate Stabilization of Exchange Rates and Contagion in the Asian Crisis Countries," paper presented at the 1999 Pacific Basin Conference, San Francisco (September).

Eichengreen, B., Rose, A., and C. Wyplosz (1996). ‘Contagious Currency Crises’ NBER Working Paper No. 5681, July 1996.

Flood, R. P., and Jeanne, O. (2000). “An Interest Rate Defense of a Fixed Exchange Rate?” International Monetary Fund Working Paper WP/00/159. Washington, D.C.

Frenkel, J. A. (1976). ‘A Monetary Approach to the Exchange Rate: Doctrinal Aspects and Empirical Evidence’. Scandinavian Journal of Economics, 1976, 78(2):200-24.

Frenkel, J. and Rose, A. (1996),’ A Panel Project on Purchase Power Parity: Mean Reversion within and Between Countries’, Journal of International Economics, 40 pp. 209-224.

Furman, J., and Stiglitz, J. E. (1998). “Economic Crises: Evidence and Insights from East Asia.” Brookings Papers on Economic Activity 2. Washington, D.C.: Brookings Institution.

Girton, L. and D. Roper (1977) ‘A Monetary Model of Exchange Market Pressure Applied to the Postwar Canadian Experience’. American Economic Review, 67, pp. 537-548.

Goldfajn, I., and P. Gupta. (1999). “Does Monetary Policy Stabilize the Exchange Rate Following a Currency Crisis?” International Monetary Fund Working Paper WP/99/42. Washington, D.C.

Gould, D. M., and Kamin, S. B. (2000). “The Impact of Monetary Policy on Exchange Rates During Financial Crises.” International Finance Discussion Paper 669. Board of Governors of the Federal Reserve System, Washington, D.C.

Gujarati, D. (2015). ‘Econometrics by Example’. London: Palgrave Macmillan Publisher.

Gujarati, D. N. and Porter, D.C. (2010). ‘Essentials of Econometrics’. New York: McGraw Hill.

Hill, R.C., Griffiths, W.E. and G. C. Lim (2008). ‘Principles of Econometrics’. New Jersey: John Wiley & Sons.

Kaminsky, G. L., and Reinhart, C. M. (1999). "The Twin Crises: The Causes of Banking and Balance-of-Payments Problems." American Economic Review, 89 (3): 473-500.

Lahiri, A. and Vegh, C. A. (2003). "Delaying The Inevitable: Interest Rate Defense And Balance Of Payments Crises," Journal of Political Economy, 3(2):404-424.

Mussa, M. (1976). ‘The Exchange Rate, the Balance of Payments and Monetary and Fiscal Policy under a Regime of Controlled Floating.’ Scandinavian Journal of Economics, 78(2):229-48.

Sachs, J., Aaron Tornell, A. and Velasco, A. (1996). ‘Financial Crises in Emerging Markets: The Lessons from 1995.’ Brookings Papers on Economic Activity, 1996, No. 1 (vol. 27): 147-199.

Tanner, E. (2001). ‘Exchange Market Pressure and Monetary Policy: Asia and Latin America in the 1990s’ IMF Staff Paper, 47 (3).